When you hear the word “budget,” the first thing you might think of is all the money you have to put aside to pay others. But not all budgets prioritize spending categories in the same way. The pay-yourself-first budget includes a line item at the top of the list for perhaps your most important spending category: you.
What is a pay-yourself-first budget?
While other budgets might allow you to set aside funds to pay off spending categories like your utility bills or groceries first, a pay-yourself-first budget (sometimes called an inverse budget) prioritizes goal-based savings categories like retirement and investments before falling short-term expenses .
“By paying yourself first, you can avoid some of the common barriers to saving, such as Bspending too much money and running out of money to save, or simply forgetting to put money aside to save while you focus on other goals,” says Heidi Johnson, Director of Behavioral Economics at the Financial Health Network.
Of course, there should be some balance in any budgeting strategy. You should be realistic about how much you can comfortably afford yourself while covering your basic living expenses.
How to create a pay-yourself-first budget
When creating a “pay-yourself-first” budget, you must first change your mindset to focus on the idea that this budget focuses on your long-term savings goals and not your short-term spending.
If you want to try the pay-yourself-first strategy, here’s how:
- Calculate your income. Before you can determine how much you have to save and cover your expenses, you need to have a solid idea of how much income you’re pouring into your bank account each month. If you don’t know right off the bat, comb through some of your most recent payslips and bank statements to determine the exact amount of your paychecks, outside work, and capital gains.
- Decide what your savings goals are. On top of that, think about covering the cost of your daily or even monthly expenses. Ask yourself what your long-term goals are and how much you need to save each month to reach those goals within the timeframe you want. Perhaps your goal is to retire early or save enough to buy a home. Once you’ve decided what you’re saving for, you can set aside a certain amount for those goals, and then use the remaining money to meet your everyday expenses, like living expenses. and groceries.
- Choose an economy vehicle. Deciding where to put your savings is just as important as deciding how much you want to save each month. The account you put your savings in can play a big part in how quickly you can achieve those goals. Pro tip: Choose a high-yield savings account to keep your savings growing over time.
- Regularly reevaluate and make adjustments. While some budgeting strategies require less maintenance than others, you should still plan to review your budget regularly to see if this strategy is still working for you and adjust your savings goals to reflect changes in your income, debt, or expenses.
“The amount of money you save varies from person to person based on your income, goals, and other circumstances,” says Kendall Clayborne, a certified financial planner at SoFi. “To determine how much money you can realistically save, I suggest you first look at your current fixed costs and spending patterns. You can then break down your goals to determine how much you need to save to reach your goal and how much you’re willing to spend.”
This is how the creation of a pay-yourself-first budget could look like in practice:
Let’s say you bring home $3,000 after taxes every month and your top two savings goals are to save for a down payment on a house and build up six months of living expenses in your emergency fund over the next 12 months. To reach your savings goals within the next year, you would need to save the following each month:
- Overall Contingency Fund Goal: $10,000
- Amount needed to reach the goal: $3,000
- Monthly savings goal: $250
- Total deposit goal: $35,000
- Amount needed to reach the goal: $4,000
- Monthly savings goal: $333
- Total Monthly Savings Goal: $583
That means that after putting $583 into your savings and emergency fund, you’ll have $2,417 left over to cover your daily expenses.
Is the Pay Yourself First Budgeting Method Right for You?
As with most things, whether this budgeting strategy is right for you depends on your individual situation and finances.
One of the advantages of this budgeting method is that it is fairly straightforward and can only take a few minutes to set up. So if you’re looking for something slimmer, this could be a good option for you.
And once you figure out your income, your savings goals, and the amount you’d like to put into your savings account, you can put those plans into action as easily as you automate your savings in your existing bank account. You can usually do this through your online bank account, mobile app, over the phone or in person at your bank branch. All you have to do is select the amount you want to transfer to your savings and how often you want those transfers to be made, and you’re all set.
“You can set up direct deposit so a portion of your paycheck goes straight into your savings account each month,” says Clayborne. And if you feel like keeping your savings and checking accounts under one roof might tempt you to overspend, you can also opt for a bank account at a different bank to keep things separate and on work toward your goals.
Pros and Cons of a Pay Yourself First Budget
Not all budgeting methods will work for you. Weighing the pros and cons of this method can help you decide if it’s the right strategy for you or if you should go back to the drawing board.
Professional: A pay-yourself-first approach reinforces a savings mentality. Instead of looking at all of your daily expenses and then seeing what you have left for your savings goals, prioritize those long-term goals first and make sure they don’t get overlooked.
Professional: This type of strategy forces you to be strategic about how you use the leftover funds and live within your means. It reduces the chances of you falling victim to a lifestyle inflation trap and going through your savings goals.
Disadvantage: If you have high-interest debt, this strategy could make it harder to pay off those balances. In these cases, you should prioritize reducing your debt before tackling your higher savings goals.
Disadvantage: It can be difficult to predict how much you’ll need to save for unexpected expenses, and you don’t want to create a situation where you’re constantly pulling money out of your savings or potentially incurring overdraft fees since it’s hard to predict how much you’ll be holding in your checking account should. “Most people find past expenses, like a flat tire or a child who needs braces, to be unusual, so they don’t consider similar expenses in the future,” says Johnson. “That can lead to an overly optimistic budget.”
take that away
If the thought of maintaining spreadsheets and the constant crunching of numbers has turned you away from traditional budgeting methods, the pay-yourself-first method could be a viable option for you. It’s easy to set up, maintain, and adjust as needed if your income or financial priorities fundamentally change.
“This strategy usually works best for people who are tempted to spend money when they see it in their checking account,” says Clayborne. “By transferring the money to another account and not seeing it as available to spend, you can push yourself to save painlessly — out of sight, out of mind.”